A commodity swap is an over-the-counter (OTC) derivative contract where two parties agree to exchange cash flows based on the price of an underlying commodity. Typically, one party pays a fixed price while the other pays a floating price based on spot market rates. These swaps allow market participants to hedge price risk or speculate on commodity price movements without physical delivery.

Commodity swaps are customized contracts that can be tailored to specific needs regarding quantity, quality, delivery terms, and settlement periods. They’re commonly used by producers, consumers, and financial institutions to manage commodity price exposure. Unlike futures contracts, swaps are private agreements that don’t require margin deposits and can be structured for longer terms with flexible payment schedules.

Real-world example: An airline enters a jet fuel swap agreeing to pay $70 per barrel fixed rate while receiving floating market prices, protecting against fuel cost increases over the next two years.